INTELLECTUAL PROPERTY: Cracking the Brazil nut

Brazil is one of the hottest real estate investment stories today. Indeed, when it comes to assessing Brazil’s attractiveness to international institutional investors, the country outranks China by several percentage points and outstrips India by almost 10 percent.

Such appeal is not hard to miss when you travel to the country. At last month’s annual Association for Real Estate and Tourism Development (ADIT) conference, held in the northeast city of Fortaleza, investors – both domestic and international – spoke with genuine excitement about Brazil’s population, its natural resources, its growing affluence and its economic growth. After decades of political and currency instability, including peak inflation rates of almost 2,500 percent, Brazil is now reaping the rewards of a fast-growing, democratic economy – an economy, investors argued, that is based on consumption rather than speculation.

It is an investment thesis that is embraced by many global corporations as they look to Brazil to help fuel their own future growth. The French hospitality group, Accor, has ambitious plans to almost double the number of hotels in its global portfolio to 7,000 over the next seven years, particularly in emerging markets such as Brazil, India and across Asia, with expectations it will open 100 new budget Formule 1 hotels in Brazil by 2018. US hospitality REIT Host Hotels and Resort also made its foray into Latin America by acquiring the JW Marriott on Rio de Janeiro’s Copacabana Beach for $47.5 million last October, following a competitive bidding process that saw up to 10 firms fight for the asset, according to people familiar with the matter.

As such, the face of the country’s real estate market is changing rapidly, and not just in the country’s hospitality sector. From the massive government-backed Minha Casa, Minha Vida (My Home, My Life) programme to the growing number of logistic warehouses, malls and offices being developed across Brazil’s regions, there are few other emerging markets that are replicating the vibrancy of Brazil with the expectations of significant investment opportunities.

Yet, despite such investment promise, concerns are rising domestically. Increased inflation, continued currency appreciation, particularly against the US dollar, and more moderate GDP growth, coupled with the need for massive infrastructure spending, are prompting many inside and outside of Brazil to ask whether international investors are being realistic over the types of returns they are expecting.

According to a recent survey of Brazil hospitality investors conducted by Ernst & Young, 64 percent expected to generate returns of 21 percent-plus from their deals over the next 12 to 24 months, including 22 percent that were targeting 26 percent-plus IRRs. However, speaking to local operating partners at the ADIT conference, PERE anecdotally was told of returns more in the low-teens to 20 percent range, prompting the question whether there is a growing disconnect between international expectations and realities on the ground.

Of course, that’s not to say there are no opportunistic returns to be had in Brazil today. Far from it. One private equity real estate player told PERE about a Rio office deal, originally underwritten at R$55 (€23.94; $33.89) per square metre that was now leasing for R$140 per square metre, while a New York-based allocator of investor equity into Brazil spoke about another Rio transaction that was generating pro-forma returns of 32 percent.

However, as Rogerio Basso, practice leader for Ernst & Young’s Latin America real estate and hospitality group, said: “Brazil is a fast-growing economy, but some international investors are still looking at it as a third-world economy and attaching a risk premium to Brazil that’s not always justifiable today.”

That pressure on returns, though, is only likely to rise in the near future. Aside from the fact that Brazil is gearing up to host the World Cup and Olympic Games in 2014 and 2016, respectively, one of the country’s biggest challenges is meeting the demand for talent in the near to medium term. According to Brazil’s labour ministry, an additional 500,000 construction workers will be needed to keep pace with the current demand for real estate, a trend that has helped pushed the number of people employed in the industry from 1.8 million in 2006 to roughly 2.8 million in 2010.

With unemployment just 6.5 percent nationally, finding best-in-class local operating partners is now one of the toughest challenges facing international real estate investors targeting Brazil. With some established private equity real estate shops revealing that it has taken them up to two years to create some of their partnerships, it’s fair to say Brazil could become a tougher nut for international investors to crack in the future.